Question

Use of preference share capital in capital structure ____________.

• A. increases Operating Leverage
• B. increases Financial Leverage
• C. decreases Operating Leverage
• D. decreases Financial Leverage

Answer 1

The correct option is B increases Financial Leverage

Financial leverage is defined as the extent to which fixed income source of funds used in the capital structure of the company. The impact of using fixed cost source of funds on financial leverage can be summaries as:

a) Financial leverage (use of debt) has a favorable impact on the EPS only when Return On Investment is more than cost of debt (net of tax).

b) The EPS keeps increasing with the use of debt amount in capital structure till ROI is more than the cost of debt.
c) Financial leverage will have unfavorable impact on EPS if ROI is less than cost of debt at any point of time.